Contrary to a common belief that state-owned enterprises are
managed in an inefficient manner, the mutual funds managed by the Investment Corporation
of Pakistan (ICP) continue to out-perform the similar funds managed by the private sector.
The accumulated losses of many of the private mutual funds have touched a level that such
funds should be liquidated. It should be a matter of concern for the Karachi Stock
Exchange (KSE), Corporate Law Authority (CLA) and Mutual Funds Association. The situation
demands an urgent redefining of the policies and the strategies to save the shareholders
who have invested their life savings in these funds..

A review of the annual accounts of mutual funds listed at KSE, for the
last three years, shows that a large number of private mutual funds have not declared
dividend to their stockholders. Most of these funds have been incurring huge losses. The
accumulated losses have eroded bulk of the paid-up capital. The provisions made against
diminution value of investment portfolio are inadequate. Had full provisions been made, a
large number of these funds would have become insolvent.

The management of private funds attribute losses to persistent bearish
trend in the stock market and decline in prices of quoted scrips. Almost all the private
funds were listed after 1994 following the unprecedented euphoria During the euphoria and
as a result of spill-over effect, prices of all the shares went up. Most of these listed
companies were not making profit even at that time or these companies were new entrants
when their shares were bought. Most of these funds have purchased the shares at very high
prices. As opposed to this, ICP has accumulated its portfolio, over the years, from the
listed companies which have been making profit and declaring regular and handsome
dividend. The funds floated by the ICP after 1993 also face a similar situation. But
still, can the rationalisation, offered by the private mutual funds, be accepted?

Listed Funds

The mutual funds listed at the KSE are divided into two distinct
groups: one managed by the ICP and the other by the private sector. ICP had floated the
first fund in 1967. Over the years the number of funds managed by the Corporation has
increased to 26. The total paid-up value of these funds, at present, is Rs. 3,140 million.
The current market capitalisation is over Rs. 2,200 million. Whereas the total paid-up
capital of thirteen (13) private mutual funds is over Rs. 1,621 million which has a
current market capitalisation of nearly Rs. 573 million.

Paid up capital

Private Mutual Funds Rs. 1,621.050 million 34%

ICP Mutual Funds Rs. 3,140.000 million 66%

Market capitalisation

Private Mutual Funds Rs. 572.550 million 21%

ICP Mutual Funds Rs. 2,200.250 million 79%

For the year, ending June 30, 1998, the ICP has paid dividend for 20
funds. and skipped payouts for the remaining five (5) funds. All of these five funds were
floated during 1993-95 period. While the highest dividend paid for 9th fund was 80 per
cent, the average dividend payout worked out to be around 24 per cent. This was higher as
compared to an average of 20 per cent paid during 1996-97. The management of ICP
attributes this to prudent management of the investment portfolio despite the bearish
sentiments looming the capital market.

In recognition of the profitability and dividend payouts, ICP has been
the regular recipient of Top 25 Companies Award of the Karachi Stock Exchange. It has
received 10 awards in 1993 and 13 each in 1994 and 1995, though the number reduced to 8 in
1996. ICP has been the only recipient of this coveted award in the sector.

Whereas only three (3) private funds have been declaring dividend and
the remaining ten (10) have not paid any dividend during the last three years. The fund
which have declared dividends are Al-Meezan, BSJS Balanced Fund and Confidence Mutual
Fund.

The dismal performance of the private funds can be gauged from the
present condition of a few players. These are: Asian Stock Fund, Tri-Star Mutual Fund,
Golden Arrow Selected Stock Fund and Growth Mutual Fund. Each of these has huge
accumulated losses. Besides, their investment portfolio at the current prices is not more
than 30 per cent of the cost at which these shares were bought. If these factors are taken
into consideration many of them have negative worth.

Accumulated loses

As on June 30, 1998

Fund Paid-up Accumulated

Capital Losses

Asian Stock Fund, 100 63

Golden Arrow 81 36

Growth Mutual Fund. 100 69

Tri-Star 50 9

There are two points of view regarding the future of private mutual
funds. One group believes that since the accumulated losses of these funds have eroded
their paid-up capital and there are no prospects for turnout, all such funds should be
liquidated immediately. The others, optimistic group, believe that in many countries
mutual funds have faced a similar situation but in due course, were able to generate
profits and therefore, let the market forces determine their fate.

The Economy

It may be true that relative performance of the economy of the country
in the recent past has not been out of line. It is also a serious concern that economic
problems, political nuisance and loss of credibility have been responsible for the
contraction of large scale manufacturing sector. It was the agriculture sector which has
provided the boost to GDP growth and partly to the agro-based industries. The quantum of
foreign trade has been shrinking. Though the GoP takes the claim of reduction in imports,
it also denotes overall economic slow down in the country.

Capital Market

According to the latest Annual Report of the State Bank of Pakistan
(SBP), the Karachi Stock Exchange remained bearish for the fourth successive year. Various
economic incentives offered by the GoP failed to revive investors' confidence during
1997-98 and enhance the GDP growth rate. The frequent off-loading of shares by domestic
and foreign fund managers, in a quest for quick gains and in the wake of uncertain
conditions, and limited interest in a few selected companies, kept the entire stock market
subdued throughout the year. The short spells of buoyancy were witnessed with intervals
but a host of adverse domestic and external factors did not allow sustained performance.

As a result of constant downward trend in the capital market since June
1997 the KSE index came down from 1566 points on June 30, 1997 to 880 points on June 30,
1998  a decline of 686 points. The first half of the year has been depressing. The
continued downslide was attributed to political uncertainty, poor law and order situation
in the country, acute liquidity crunch and massive devaluation of Pak rupee.

In the second half, despite concerted efforts of GoP the market
performance remained sluggish. In May 1998, after the nuclear test, economic sanctions
were imposed on Pakistan. This resulted in another spell of sharp decline in the prices of
shares. The breach in the credibility gap continued due to tussle of GoP with the IPPs
resulting in overall selling pressure.

Regarding poor performance of private mutual fund, a large number of
securities analysts say, "Almost all the private mutual funds were floated after 1994
when the downslide has started. Many of these funds had huge funds at their disposal.
Instead of making prudent use of the funds, their management picked up the shares
irrespective of economic fundamentals for those sectors. If one looks at the composition
of portfolio of some of the funds, it is found that some of them have bought shares at
unrealistically high price. The quoted prices of such shares have reduced to less than one
fourth now. A large number of these companies have not paid any dividend over the
years."

According to some analysts, in this situation the funds had two
options: to sell the shares at prevailing lower values and take into account immediate
losses or continue to hold these shares till the time it becomes mandatory for them to
make full provisions against diminution value.

In case, they had exercised the first option, the chances of making
huge loss were high. Therefore, most of these funds continued to classify their portfolio
under 'short-term investment' and made only partial provision against diminution value and
avoided losses. The law allows the management of mutual funds and investment banks to
treat such investment as short-term investment for a maximum period of 3-years. This
period will be over for most of the mutual funds by June 30, 1999 and the second option
will not be available after this date.

Sector Fundamentals

It is important to understand the fundamentals for the quoted companies
belonging to various sectors. As a result of rising interest rates and inflationary trend
the profit margins of all the companies had remained low. However, companies that have
seen earnings grow due to increased sales volumes continued to be better placed.

As GDP growth slowed, banks found it increasingly difficult to maintain
deposit growth. The major problems for the large banks were their bad debts and
non-performing portfolio. The situation turned worse due to declining repayment ability of
the borrowers. Despite campaigns the recoveries have remained dismal. It is extremely
unlikely that there will be more than 20 to 25 per cent recovery from these loans.

The companies belonging to textile sector, despite availability of
cotton and man-made fibres did not succeed in posting good profit. Similarly the profit
margins of companies belonging to polyester staple fibre (PSF) sector witnessed erosion in
profit margins due to poor capacity utilization and inflationary trend.

The profit margins of oil refineries also reduced due to reduction in
the global prices of crude oil. The reduction in profit was due to the dollar-based
pricing formula restricting them to retain more than 40 per cent of profit on equity.
Similarly the profit margins of gas distribution companies also came under pressure. But
the real problem of companies belonging to these two sectors was intercorporate debt. This
on the one hand forced them to borrow more  increasing their financial cost and did
allow them to undertake BMR activities.

Mal-practices-

Though, bearish capital market is one of the reasons for the poor
performance of mutual funds some of the analysts do not agree with this rationalisation.
They say that the losses of private mutual funds were not due to the bearish sentiments
prevailing in the capital markets. It was the mal-practice of the management which was the
reason for their dismal performance. Some of the analysts alleged that the management of
private funds kept all the profit generating transactions in their personal accounts and
charged the loss making transactions to mutual funds. They say that most of these funds
have been indulging in such practices and only a detailed scrutiny of the transactions
conducted by the sponsors and those recorded in the accounts of the funds can substantiate
the belief. Their allegations are based on a point that the sponsors of many funds are
also members of KSE and are actively involved in securities trading. They demand that it
is the responsibility of both the KSE and CLA to undertake detailed audit of the
transactions and if any of the director is found guilty, should be punished accordingly
because it is unethical and a breach of trust of the shareholders.

The other observation is that many of the private funds became prey of
trading rather following the policy of long-term investment. The CEO of a private fund
said it was need of the time. Fund management have to sell and buy equities to reduce the
average cost in the declining trend. However, this rationalisation was termed incorrect by
some analysts. They say that trading of equity is the right of the management but once it
reaches the level of speculative trading it becomes an obsession. The management buys if
the price goes down by 50 paisa and sells when there is similar increase to square-up the
losses but trading in equity, purely on speculation rather than on economic fundamentals,
is a 'zero-sum game.' They also say that it is very unfortunate that people in this
country follow herd-mentality rather than giving weightage to economic fundamentals but it
is the 'name of the game'.

OUTLOOK

According to the latest report of SBP the current fiscal year is
expected to close with a 4 per cent growth in gross domestic product (GDP) against a
target of 6 per cent. Even this lower forecast is based on an assumption that any untoward
development during the remaining months of current fiscal year does not take place. The
economy is expected to recover in the remaining months due to reduction in the perceived
risk of Pakistan. One of the reasons for constant downgrading of Pakistan's
creditworthiness was the potential default in external debt servicing. Since Pakistan has
reached an understanding with the IMF the flow of funds is expected to resume soon. This
will also pave way for rescheduling of country's external debts.

On the domestic front, there are prospects for modest cotton crop and
production of sugarcane sufficient to produce at least one million tons surplus sugar.
This will improve the share of agriculture sector in the GDP and will also improve the
performance of the large scale manufacturing sector. The import bill of wheat, chemical
fertilizer and oil is also expected to remain low as compared to previous year.

Though many new gas fields have been discovered in the country during
last few months some of the analysts/brokerage house operating in Pakistan have downgraded
gas sector in the country. The fuel and energy sector has been an attractive sector for
both local and foreign investors but has been downgraded from 'neutral' to 'underweight'.
This downgrading was based on the premise that the profitability of the companies
belonging to this sector is forecast to remain depressed in 1998-99. This prediction is
based on a number of factors which include poor liquidity being at the top. The guaranteed
return formula of gas distribution companies was termed inadequate and price freeze was
said to be responsible for the reduction in profit forecast .

The outlook for ICP-managed funds continues to be bright except for the
five funds floated after 1993. They will continue to dish out higher dividend because of
the policy. ICP, as a policy does not issue Bonus shares. It has raised paid-up capital of
most of its funds through Right Issue. The management believes that the time is not
conducive for Right Issues, but, some analysts disagree with the policy. They say that if
ICP issues Right shares these will be fully subscribed because the existing will not like
to loose the opportunity. Their conviction is based on the recent over-subscription of
TFCs by Interbank. They also say that since the average equity cost of many of the ICP
managed funds is exceptionally low and current quoted price of most of the shares are also
low it is the time for the corporation to expand its portfolio.

The outlook for private funds is expected to remain gloomy not because
of the market sentiments but due to their own practices followed in the past. It will take
many years to wipe-out the accumulated losses. Unless these losses are fully eradicated
they will not be in a position to declare any dividend. They suggest that most of these
funds should be liquidated immediately. Even mergers and acquisitions cannot help.